Learning From Trader Joe's, Joe Coulombe

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It's a rare person who can run their own business, and rarer still are those who can do it well. And in a world of stiff competition and consumer fickleness, those people who's businesses can both survive and thrive in that environment are probably the rarest of them all.

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If you choose a manager to whom you entrust your capital, in the words of Charlie Munger , choose a 'business fanatic.' Such individuals live, sleep and breathe their businesses. They're not bound by the same restraints as most business people; constantly pushing boundaries, trialing new approaches, thinking outside the box, challenging conventional wisdom and always looking for business improvements. If you're in business, these are the last type of people you want to compete with. One man that epitomized such fanaticism was the late Joe Coulombe , founder of the convenience store chain that carried his name, Trader Joe's .

“Edward H. Heller, a pioneer venture capitalist used the term 'vivid spirit' to describe the type of individual to whom he was ready to give significant financial backing. He said that behind every unusually successful corporation was this kind of determined entrepreneurial personality with the drive, the original ideas, and the skill to make such a company a truly worthwhile investment.” Phil Fisher

Joe tells his story in the book, ' Becoming Trader Joe - How I Did Business My Way and Still Beat the Big Guys .' It contains a wealth of wisdom, particularly when it comes to thinking about running a successful retailer. Over more than a quarter of a century, Trader Joe's sales grew at a compound rate of 19% per year and the company's net worth grew at a compound rate of 26% per annum over the same period - no mean feat for a commodity business that's hard to differentiate. Furthermore, the business never lost money in a year and incredibly each year was more profitable than the last.

When the competitor 7-Eleven extended it's footprint into California in the 1970's, Pronto Markets, the precursor to Trader' Joe's, already enjoyed the highest sales per store of any convenience operator in America by a factor of three. A high wage policy, strong locations, a few liquor licences, and the beginnings of a differentiated strategy through product knowledge was the core of their success.

One of the mental models I particularly enjoyed in the book was Joe's concept of ' Double Entry Retailing .' A form of second level thinking, Joe recognised that making changes to Demand Side factors had an influence on Supply Side factors which aren't always obvious. A striking example was the introduction of orange juice freshly squeezed on the premises. While a great Demand Side success - customers embraced the product - it was a total nightmare to administer because of the Supply Side issues; the great variation in sweetness of oranges over the course of a year, difficulty in ensuring machines squeezed the right amount and disposal of the leftover rinds. As a result it was eventually phased out.

You'll recognise many of the characteristics that form a common link with the other great businesses we've studied. I've included some of my favourite extracts from the book below.

• 1. Harnessing Demographic & Technological Change
• 2. Obliquity
• 3. A Bias to Action & Tenacity
• 4. Value, Empower & Pay Employees Well
• 5. Retail & Real Estate Decisions
• 6. Product Knowledge
• 7. Four Tests
• 8. Purpose
• 9. Radical Transparency
• 10. Growth
• 11. Smallness & Empowerment
• 12. Marketing & Customers
• 13. Word of Mouth
• 14. Pricing
• 15. Retailing
• 16. Win-Win
• 17. Committees
• 18. Economies of Scale
• 19. Focus & Outsource
• 20. Business Problems
• 21. Adapt, Challenge the Status Quo
• 22. Mental Model - Double Entry Retailing
• 23. Employee Ownership
• 24. Summary

'The clue, the keystone of the arch of Trader Joe's , was a small news item in Scientific American in 1965. When we left Stanford, my father-in-law, Bill Steere, a professor of botany, gave me a subscription to Scientific American. In terms of creating my fortune, it's the most important magazine I've ever read . The news item said that, of all the people in the US who were qualified to go to college in 1932, in the pit of the Depression, only 2 percent did. By contrast, in 1964, of all the people qualified to go to college 60 percent in fact actually did. The big change, of course, was the GI Bill of Rights that went into effect in 1945.

A second news item, one from the Wall Street Journal, told me that the Boeing 747 would go into service in 1970, and that it would slash the cost of international travel . In Pronto Markets we had noticed that people who travelled - even to San Francisco - were far more adventurous in what they were willing to put in their mouths. Travel is, after all, a form of education.

Trader Joe's was conceived from those two demographic news stories . What I saw here was a small but growing demographic opportunity in people who were well educated. 7-Eleven, and the whole convenience store genre, served the most basic needs of the most mindless demographics with cigarettes, Coca-Cola, milk, Budweiser, candy, bread, eggs. I saw an opportunity to differentiate ourselves radically from mainstream retailing to mainstream people .”

“I hope you'll consider the following, my favourite quote from my favourite book on Management, 'The Winning Performance' by Clifford and Cavanaugh,' ' The fourth (general themes in winning corporations] is a view of profit and wealth-creation as inevitable byproducts of doing other things well . Money is a useful yardstick for measuring quantitative performance and profit and an obligation to investors. But … making money as an end in itself ranks low .'”

“In 1962, Barbara Tuchman published 'The Guns of August', an account of the first ninety days of WWI, It's the best book on management - and, especially, mismanagement - I've ever read. The most basic conclusion I drew from from her book was that, if you adopt a reasonable strategy, as opposed to waiting for an optimum strategy, and stick with it, you'll probably succeed. Tenacity is as important as brilliance .”

“ Trying to find an optimum solution in business is a waste of time ; the factors in the equation are changing all the time.”

“You've got to have something to hang your hat on. The one core value I chose was our high compensation policies , which I put in place from the very start in 1958… This is the most important single business decision I ever made: to pay people well . First Pronto Markets and then Trader Joe's had the highest-paid , highest benefitted people in retail .”

“Time and again I am asked why no one has successfully replicated Trader Joe's . The answer is that no one has been willing to pay the wages and benefits , and thereby attract - and keep - the quality of people who work at Trader Joe's.”

“[I was asked,] 'But how could you afford to pay so much more than your competition ?' The answer, of course, is that good people pay by their extra productivity. You can't afford to have cheap employees .”

“Equally important was our practice of giving every full-time employee an interview every six months . At Stanford I'd been taught that employees never organise (join unions) because of the money; they organise because of un-listened-to grievances .”

“ The [store] Captains had the salary plus a bonus that theoretically had no limit . The bonus was based on Trader Joe's overall profit, allocated among the stores based on each store's contribution. In 1988, several Captains made bonuses of more than 70 percent of their base pay . Unless a bonus system promises, and delivers big rewards, it should be abandoned .”

“My idea, often stated to everybody, was that the [store] Captains should have the chance to make more than executives in the office . In a traditional chain store, managers aspire to become bureaucrats with cushy, high-paying jobs in the office. I wanted to kill such aspirations at the start .”

“Part timers .. at a time when the minimum wage was $4.35, we often paid $13.00 per hour because these people were worth it.”

“ Productivity in part is a product of tenure. That's why I believe that turnover is the most expensive form of labor expense .”

“ We instituted full health and dental insurance back in the 1960's when it was cheap. When I left, we were paying $6,000 per employee per year!”

“ Each full-timer was supposed to be able to perform every job in the store , including checking, balancing the books, ordering each department, stocking, opening, closing, going to the bank, etc. Everybody worked the check stands in the course of the day, including the [store] Captain.”

“ In thirty years we never had a layoff of full-time employees . Seasonal swings in business were handled with overtime pay to full-time employees, and by adjusting part-time hours. The stability of full-time employment at Trader Joe's was due in part to caution opening new stores, and insisting on high volume stores .”

“ Cost of goods sold is the dominant expense . The funny thing is that grocers seem to spend more effort squeezing payroll than squeezing Cost of Goods Sold, though there is at least five times more opportunity in the latter.”

'First we upped the investment ante by taking only prime locations, which could generate the most sales , even though the rents were higher. A lease is an investment, perhaps the most serious and certainly the least changeable a retailer can make . Financially, a lease is simply a long-term loan… Most retail bankruptcies come from bad real estate leasing decisions … Early in my career I learned there are two kinds of decisions: the ones that are easily reversible and the ones that aren't . Fifteen-year leases are the least-reversible decisions you can make . That's why, throughout my career, I kept absolute control of real estate decisions.”

“The keys to management are strong locations with good people .”

“People often ask me, how many stores did we have at such-and-such time? It's the wrong question to ask. What's important is dollar sales. For example, from 1980 to 1988, we increased the number of stores by 50 percent but sales were up 340 percent .”

“ My preference is to have a few stores, as far apart as possible, and to make them as high volume as possible .”

“Too many stores, to many irreversible leases, too much geographical saturation was a recurrent theme in the failure of American retail chains in the twentieth century .”

“Ancient Mariner Retailers claim that ' volume solves everything .' If it's profitable volume, they're right. Things go most sour in the lowest-volume stores . It's like riding a bicycle, the faster it goes, the more stable it is. The 'normal distribution' of most chains is 20% dogs, 60% okay stores, and 20% winners . I believe in ruthlessly dumping the dogs at whatever cost . Why? Because their real cost is in management energy . You always spend more time trying to make the dogs acceptable than in raising the okay stores into winners. And it's in the dogs that you always have the most personnel problems."

“I believe that the sine qua non for successful retailing is demographic coherence : all your locations should have the same demographics whether you are selling clothing or wine .”

“I liked semi-decayed neighbourhoods, were the census tract income statistics looked terrible, but the mortgages were all paid-down, and the kids had left home. Housing and rental prices tend to be lower, and more suitable for those underpaid academics. Related to this, I was more interested in the number of households in a given area than the number of people in a ZIP code. Trader Joe's is not a store for kids or big families. One or two adults is just fine.”

“Computerisation has radically upgraded the statistics available: I'd probably do it more formally now. But there's no substitute for 'driving' a location to ferret out traffic problems. And do it at night, too.”

“I hardly need to mention that a trading area is rarely determined by a radius . It's determined by geographical barriers, boulevard access, and where the demographics lie .”

“ Let's go back to the question of number of stores. How do you space them? Here are some parameters: You need to have enough stores in a trading area to economically amortise the radio advertising. You need enough stores in an area to have a large enough pool of employees . My rule was that distance between stores should not be measured in miles but in driving time. I wanted no less than twenty minutes between stores. That pretty much avoided the dread word, cannibalisation. Could a given trading area support more Trader Joe's? Almost certainly! I figured we could break even at ten thousand core residences. But I wanted super-volume stores . If the credo that super-volume stores have the fewest operating problems is valid, then the overall health of the chain, in the long run, is maximised.”

“ How many trading areas should you enter? As long as you can preserve the culture of the company, and as long as logistics don't kill you, go ahead .”

“Never, never, never sign a lease with a 'continuous operation' clause. That clause means you must stay open - you can't 'go dark' and just pay the rent.”

“ The buyers at the supermarket chains knew nothing about what they sold , and they don't want to know. What they did know all about was extorting slotting allowances, cooperative ad revenue, failure allowances, and back-haul concessions from the manufacturers .”

“The advantage of hard liquor merchandise was that it met three tests:

a) A high value per cubic inch, essential to a small store format

b) A high rate of consumption

c) It had to be easily handled

If we could have added a fourth test, it would be that we had to be outstanding in the field. Still trying to maximise the use of a small store, I looked for categories that met the Four Tests ; high value per cubic inch, high rate of consumption; easily handled; and something in which we could be outstanding in term of price or assortment. For example, diamonds met the first test but flunked the second. Fruits and vegetables met the first and second but flunked the third because produce requires constant reworking. Fresh meat flunked the third test even more.”

“ Most of my ideas about how to act as an entrepreneur are derived from ' The Revolt of the Masses ' by Jose Ortega y Gasset , the greatest Spanish philosopher of the twentieth century. I believe it offers a master 'plan of action' for the would-be entrepreneur, who usually has no reputation and few resources . Ortega offers an explanation of how such a person can get an enterprise started. In the context of the career of Julius Caesar, an entrepreneur who started without power, Otega says of the state:

'Human life, by its very nature, has to be dedicated to something, an enterprise glorious or humble, a destiny illustrious or trivial .. The State begins when groups, naturally divided, find themselves obliged to live in common. The obligation is not of brute force, but implies an impelling purpose, a common task which is set before the dispersed groups . Before all, the State is a plan of action and a Programme of Collaboration. The men are called upon so that together they may do something .. It is pure dynamism, the will to do something in common, and thanks to this the idea of the state, is bounded by no physical limits .”

Most of my career has been spent selling ' plans of action and programmes of collaboration .' If you want to know what differentiates me from most manager's that's it . From the beginning, thanks to Ortega y Gasset, I've been aware of the need to sell everybody.”

“Throughout my career, my policy has been full disclosure to employees about the true state of affairs , almost to the point of imprudence. I took a cue from General Patton, who thought that the greatest danger was not that the enemy would learn the plans, but that his own troops would not .”

“ Growth for the sake of growth still troubles me. It seems unnatural, even perverted . This helps explain why I went from 1974 to 1978 without opening another store. To keep sales increasing during the mid-1970s, we relied on new ideas implemented in existing stores. This was my favourite form of growth. I don't think that any given store ever fully realises its potential .”

“We developed a prototype [Trader Joe's] store of 4,500 square feet. Here's a good question: Given my need to get away from convenience stores, why did I stick with small stores? The answer was verbalised for us in 'In Search of Excellence,' Tom Peter's best-selling book on management. He called it ' The Power of Chunking ':

'The essential building block of a company is the section [which] within its sphere does not await executive orders but takes initiatives . The key factor for success is getting one's arms around almost any practical problem and knocking it off… The small group is the most visible of the chunking devices.'

The fundamental 'chunk' of Trader Joe's is the individual store with its highly paid [store] Captain and staff ; the people who are capable of exercising discretion . I admire Nordstrom's fundamental instruction to its employees: use your judgement. Trader Joe's finally settled down at an average of about eight thousand square feet in the 1980's, but the concept of a relatively small store with a relatively small staff remains in force .”

“At all times I wrote the Fearless Flyer [marketing newsletter] for over-educated, underpaid people. This requires two mindsets:

Trader Joe's Fearless Flyer Newsletter

1) There are no such things as consumers - dolts who are driven by drivel to buy stuff they don't need or even want. There are only customers, people who are reasonably well informed, and very well focused in their buying habits .

2) We always looked up to the customers in the text of the Fearless Flyer . We assumed they knew more than they did, we never talked down to them.

3) Given the first two assumptions, we assumed that our readers had a thirst for knowledge, 180 degrees opposite from supermarket ads. We emphasised ' informative advertising .'

Originally, we distributed the Fearless Flyer only in stores and to a small but growing list. [Later,] by mailing to addresses rather than to individuals - by blanketing entire ZIP codes - we were able to tremendously expand the distribution of the Fearless Flyer. The ZIPs to which we mailed, of course, were chosen on the basis of the likely concentration of over-educated and underpaid people .”

“ Word of Mouth: The Power of True Believers . As everyone knows, word of mouth is the most effective advertising of all . I have been known to say that there's no better business to run than a cult. Trader Joe's became a cult of the over-educated and underpaid , partly because we deliberately tried to make it a cult and partly because we kept the implicit promises with our clientele.”

“ There aren't many cult retailers who successfully retain their cult status over a long period of time . A couple in California are In-N-Out Burger and Fry's Electronics. But across America, in every town, there's a particular donut shop, pizza parlour, bakery, greengrocer, bar, etc. that has a cult following of True Believers.”

“One of the fundamental tenets of Trader Joe's is that retail prices don't change unless costs change . There are no weekend ad prices, no in-and-out pricing… I have always believed that supermarkets pricing is a shell game and I wanted no part of it .”

“ The fundamental job of a retailer is to buy goods whole, cut them into pieces, and sell the pieces to the ultimate consumers . This is the most important mental construct I can impart on those of you who want to enter retailing. Most 'retailers' have no idea of the formal meaning of the word. Time and again, I had to remind myself just what my role in society was supposed to be.”

“[We decided] no outsiders of any sort were permitted in the store . All the work was done by employees.]”

“From 1958 through 1976, we tried to carry what the customer asked for, given the limits of our small stores and other operational parameters. Each store probably had access to ten thousand stock keeping units (SKUs), of which about three thousand were actually stocked in any given week. By the time I left in 1989, we were down to a band of 1,100 to 1,500 SKUs , all of which were delivered through a central distribution system.”

“Along the way not only did we drop a lot of products that our customers would have liked us to sell, even at not-outstanding prices, but we stopped cashing checks in excess of the amount of purchase, we stopped full-case discounts, and we persistently shortened the hours . We violated every received wisdom of retailing except one: we delivered great value, which is where most retailers fall .”

“ [We were] willing to discontinue any product if we were are unable to offer the right deal to the customer .”

“Instead of national brands, [we] focused on either Trader Joe's label products or 'no label' products like nuts and dried fruits.”

“ We wouldn't try to carry a whole line of spices, or bag candy, or vitamins. Each SKU had to justify itself as opposed to riding piggyback into the stores just so we had a 'complete' line . Depth of assortment was of no interest .”

“ Each SKU would stand on its own two feet as a profit centre . We would earn a gross profit on each SKU that was justified by the cost of handling that item. There would be no 'loss leaders.' ”

“ Above all we would not carry any item unless we could be outstanding in terms of price (and make a profit at that price) or uniqueness. ”

'I do not believe in keeping 'spoils' in the back room until some salesperson comes by to pick them up. I believe that products should move in only one direction, never back up the supply chain . When a bottle was broken, a can dented, or a 'short fill' was discovered, it went to the trash bin.”

“A guideline: No private label product was introduced for the sake of having a private label . This is 100 percent contrary to the policy of most supermarkets … Each private label product had to have a reason, a point of differentiation .”

“ The willingness to do without any given product is one of the cornerstones of Trader Joe's merchandising philosophy .”

“ No bulky products like paper towels or sugar, because the high-value-per-cubic inch rule still prevailed .. We simply went out of business on the 'bulkers' and did not replace them with private labels.”

“ I believe in the wisdom that you gain customers one by one, but you lose them in droves .”

“Back in 1967, [we] made a bet that rising levels of education would fragment the masses, that a small but growing group of people would be dissatisfied with having to consume what everybody else consumed … This philosophical approach put us in conflict with the mainstream of American retailing, which emphasises continuous products . Thus when a supermarket promotes Coca-Cola it doesn't have to explain that Coca-Cola is a secret formula for a soft drink created a century ago in Atlanta.. Wines have not been popular in America because, intrinsically, they are not continuous products . You can't just order up some more sugar and chemicals and make another batch. In 1987, I outlined to the buyers where I thought we should go:

1) we want continuous products . Any sane person does. We want continuous products which are profitable without creating a high-price image.

2) to create such products, they needed to be differentiated at least in order to avoid direct price comparison .

3) products in which we had an absolute buying advantage . For example, we were the largest seller of cheap Bordeaux blanc in the United States.

4) I was willing to continue to indulge in the spectacular 'closeout' sales of branded products, but I wanted to do so in the context of much greater overall sales, principally generated by continuous products, most of them private label .”

“I don't think that the internet grocery store will successfully invade food retailing because you're dealing with four different temperatures : dry grocery, refrigerated products, frozen products, and ice cream when you try to home-deliver foods.”

“ Showmanship is the sum total of all efforts to make contact with the customer . It's the most ephemeral, the most difficult, and the most important of the Demand Side activities .”

“ All the research on whether people turn to the left or the right, or whether you can 'force' people to the rear of the store, is irrelevant if you're a value retailer .”

“ Honour thy vendors: After all, these are the guys you're buying from. They should not be treated as adversaries . Five year plan 1977 said, 'Buying, therefore, is not just a matter of trying to beat down suppliers on price. It is a creative exercise of developing alternatives.' Many of our best product ideas and special buying opportunities came from our vendors .”

“ Vendors should be regarded as an extension of the retailer , a Marks and Spencer concept. Their employees should be regarded almost as employees of the retailer . Concern for their welfare should be shown, because employee turnover at vendors sometimes can be more costly than turnover of your own employees.”

“ Tenants who enter negotiations with the idea of beating the landlord at the objective future game usually get the kind of landlords they deserve . And vice versa.”

“ Other non-merchandise vendors are very much extensions of Trader Joe's and should be treated as much . Since we owned no trucks, warehouses, etc., I asked our people to keep track of the outsourced drivers and do their best to see that our contractors were paid reasonable wages with reasonable working conditions. Turnover is the most expensive labour expense !'

“I want to make it quite clear that I called all the shots. I reject management by committee .”

“The point where the 'buying power' and 'selling power' curves cross each other creates the magical physical thresholds. There are two magical physical thresholds that a retailer must achieve to be competitive: the truckload, and the ocean container load . These thresholds mark the limit of most economies of scale .”

“ We tried to stay out of all functions that were not central to our primary job in society: namely, buying and selling merchandise .. [We'd] been getting rid of all functions except those buying and selling . We got rid of our own maintenance people, we sold off almost all the real estate we had acquired during the 1970's, we never took mainframe computing in-house, etc.

Some choice quotes from Dr. Drucker: ' In-house service activities have little incentive to improve their productivity .. The productivity is not likely to ramp up until it is possible to be promoted for doing a good job at it. And that will happen in support work only when such work is done by separate, free standing enterprises .'”

“ All businesses have problems. It's the problems that create the opportunities . If a business is easy, every simple bastard would enter it.”

“This is one of the most important things I can impart; in any troubled company the people at lower levels know what ought to be done in terms of day-to-day operations. If you just ask them, you can find answers .”

“Believe me, you have to have a system for everything that has to happen in your business - you just may not be conscious of it. And you probably have still other systems that are not needed. That's why The Winning Performance calls for a ' continued contempt for business as usual .' To practice 'constitutional contempt,' you have to arrive every day with the attitude, 'Why do we do such-and-such that way?' Better yet, why do we do it at all? Usually the answer is, 'We've always done it that way,' 'That's the way we did it at my last job,' or 'All our competitors are doing it .'

“I hit on the idea of using double entry accounting as an analogy, what I call Double Entry Retailing . On the left side of the ledger is the business in terms of how its customers see it: I call this the Demand Side . On the right side of the ledger are the factors that limit or determine the retailer's ability to satisfy those demands: the Supply Side .

All businesses, whether manufacturing, wholesaling, services, etc., have [the] fearful symmetry of both Demand and Supply sides. And all businesses are subject to the ultimate supply-side constraint of cash: you can do anything, no matter how stupid, within that fearful symmetry, as long as you don't run out of cash. From my view, the Demand Side of Retailers can be analysed in terms of five variables:

Here are factors on the Supply Side :

As in double entry accounting, the change in any factor must be matched by a corresponding change in another factor . For example, a decision to increase geographical convenience (Demand Side) obviously involves some change of policy with landlords (Supply Side) including the amount of rent you're willing to pay. Consider how Barney's paid through the nose because they thought they had to offer the geographical convenience of being in Beverly Hills. How big a factor was this in Barney's subsequent bankruptcy? Was it Demand Side success at the price of Supply Side failure?

The lists above aren't much different from other businesses. What distinguishes retailing is the asymmetry of the fearful symmetry: the huge number of customers (Demand Side) vs. the number of suppliers. This is the exact opposite of a government defence contractor.

This lopsided butterfly may cause a retailer to act as if the only people they have to 'sell' to are customers: the Demand Side. That's a major mistake. All the people on the supply side have to be sold, too .”

“One of the smartest things we ever did was to cut the hours of Trader Joe's. This is mostly a Supply Side question, but the quality and attitude of the employees handling our customers is a Demand Side factor.”

“ From the beginning of Pronto Markets, one of my basic principles, one of my basic goals, was employee ownership of the business . Getting there, however, was complicated.”

I found the similarities between Trader Joe's approach to retailing and the German retailer Aldi strikingly similar. Despite being on opposite sides of the world, both businesses evolved complementary retailing practices: a focus on private label, above market wages for employees, a win-win mentality and continuous innovation . It's little wonder the Albrecht family were attracted to the business. Aldi acquired Trader Joe's in 1979 and retained Joe as the independent manager for another ten years.

Paying staff well, empowering and sharing information with them and maintaining smallness are consistent themes across many of the successful business stories we've studied. When it comes to the specifics of retailing, the analogy of super-volume stores better able to provide balance is a useful one. As are the insights into economies of scale, pricing strategy, jettisoning poorly performing stores, the power of word-of-mouth marketing and the means to abolish bureaucracy through the outsourcing of non-essential functions.

Every business has its own quirks and idiosyncrasies. Identifying what they are and how they contribute to a firm's success can provide clues in our own quest to find compounding machines; in the long run, it's business success which determines share prices. The more businesses you study, the larger the toolkit of mental models you'll have to apply in your investment endeavours.

Source:

' Becoming Trader Joe - How I Did Business My Way & Still Beat the Big Guys ,' Joe Coulombe, Patty Civalleri. Harper Collins. 2021.

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Article by Investment Masters Class

Updated on Oct 26, 2021, 1:11 pm

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